U.S. Office Market Makes Noticeable Progress

Feb 12, 2013

Here’s some positive news that will help get 2013 off to a good start: the U.S. office market experienced a significant upturn in performance in 2012 and is positioned for continued steady improvement this year.

That was the consensus of a panel of sector experts on a recent episode of the "Commercial Real Estate Show." The show provided an enlightening look at the office market, examining vacancy rates, net absorption, top-performing metro areas and other issues that could affect office properties.

Welcome Numbers

The national office vacancy rate dropped 50 basis points in 2012 to 12.3 percent, and national net absorption totaled a positive 59 million square feet, up a whopping 43 percent from 2011, said Walter Page, director of research for Costar Group.

On a national basis, rents also increased by 1.7 percent, Page added. “[2012] was the first year [since the recession] of what I would call a significant upturn in the rent situation,” Page said. “So it was a pretty good year for the office market.”

In San Francisco, clearly the strongest office market in the nation right now, rents spiked by an eye-popping 14.6 percent, according to CoStar. So what’s in the water out there? Page says a booming tech sector and virtually no new construction have combined to produce soaring rents and plunging vacancies.

Other strong office markets include cities in which the tech or energy sectors are prevalent, such as Boston, Houston and Seattle. On the flip side, the Washington D.C. and northern New Jersey areas struggled in 2012, he said.

Nationwide, the lack of new construction is an important component of the sector’s recovery, as is the fact that the bulk of new jobs being created are office-using positions, noted Mitch Roschelle, a partner at PricewaterhouseCoopers and the leader of the firm’s U.S. Real Estate Advisory Group.

“You’re only adding a relatively small [amount] of new stock and with those jobs that are being created, that’s the perfect storm in a good way for rent growth and occupancy pick-up,” said Roschelle, who added that the pace of new construction could pick up noticeably in late 2013 or early next year.

To sum up, the closer in town an office property is, the more likely it is to be doing well. According to CoStar, the national vacancy rate for office sites in central business districts dropped 30 basis points in 2012 to 11.2 percent, while the rate for closer-in suburban properties declined 60 basis points to 12.8 percent. The vacancy rate for office buildings in outer suburbs is 13.8 percent.

Suburban vs. Intown

To sum up, the closer in town an office property is, the more likely it is to be doing well. According to CoStar, the national vacancy rate for office sites in central business districts dropped 30 basis points in 2012 to 11.2 percent, while the rate for closer-in suburban properties declined 60 basis points to 12.8 percent. The vacancy rate for office buildings in outer suburbs is 13.8 percent.

As for Class A vs. Class B properties, the former accounted for 72 percent of the net absorption last year despite representing only 34 percent of the market stock. Furthermore, the average rent for a Class A site grew 1.9 percent compared with 1.5 percent for a B property. “Clearly, we’re seeing a flight to quality, and Class A is definitely winning,” Page said.

In the Trenches

After getting the macro, analytical perspective from Page and Roschelle, I spoke with two men whose firms both own and develop office properties to get their “in-the-trenches” take on the sector.

Jim Bacchetta, vice president of Highwoods Properties, largely echoed the positive sentiments of Page and Roschelle. “We’ve seen eight or more quarters of net positive absorption in most of our markets, and I expect that trend to continue,” he said. “I think it’s going to be a slow, steady, continuing recovery. We’ve seen the worst, and clearly we’re trending upward.”

Bacchetta did sound one note of caution, saying that the long term economy is headed for big troubles if the federal government does not reduce its deficits. “Simplify our tax code, cut taxes, but, mostly, get a grip on, modify and reduce entitlement spending,” he said. “That’s what’s killing us [and] that’s what’s going to kill us in in the long run.”

In light of anticipated rent growth, tenants would be wise to ink long-term leases to lock in lower monthly rates, advised David Tennery, principal of Regent Partners' Office Properties and Development Group. However, “if I’m a landlord, I’m going to want to go mid- to short-term.”

Tennery also pointed out that some larger office markets are benefitting from corporations consolidating district offices into one location. “We’re starting to see some consolidation of some corporate facilities where rightsizing has taken place, and small district offices in some of the secondary and tertiary markets are closing in favor of a regional hub,” he said.